Roosevelt and Keynes

As we learned in the previous film, Keynes gave his personal advice to President Franklin D. Roosevelt in an open letter. In this article, Sir Vince Cable highlights key components of that advice and discusses the extent to which it influenced Roosevelt. Vince also discusses whether policy makers can gain insights from Keynes’ letter as they continue to respond to the post-2008 recession.

It is often stated that the first practical application of Keynesian economics was the Roosevelt New Deal. Roosevelt came to power in 1933 in the wake of the Great Crash in the USA which produced economic depression and mass unemployment in America, Canada and some European countries, notably Germany and Austria. Between 1929 and 1933 the GDP of the USA fell by just over 30% (it fell, by contrast, only 5% after the recent financial crisis in 2008). Britain was less seriously affected (having suffered a major slump a decade earlier) but unemployment rose from 10% in 1929 to 21% in 1931. Keynesian economics was a response to this economic – as well as social and political - crisis.

Roosevelt’s ideas and policies developed largely independently of Keynes (until the end of the Second World War when Keynes played a key part in the Bretton Woods negotiations establishing the post-war order). But one key contribution which Keynes made to the US debate was his ‘open letter’ to President Roosevelt. We have no evidence that Roosevelt read it and, at least initially, his administration showed a very un-Keynesian preoccupation with balanced budgets and government debt levels (until the US, having recovered from the Depression, fell back again in 1936/7. We recommend returning to Keynes’ Open Letter to President Roosevelt and there are some notes below on the key economic concepts used:

In paragraph 3, Keynes made a distinction between long term reform (actions like establishing the minimum wage; restricting production to push up prices; strengthening trade unions; splitting banks; and actions against business monopolies) and short term recovery by boosting demand. Roosevelt was more interested in the former; Keynes in the latter. Indeed, Keynes criticized the reforms which could “upset the confidence of the business world.”

Keynes describes (in paragraph 5) three mechanisms to increase purchasing power: first, promoting personal consumption, by tax cuts for example which he believed would not work on a sufficient scale; second, getting business to invest more through low long term interest rates, which he strongly supported as a secondary measure (and which he saw as a key factor in the recovery of the UK); and third, government stimulating the economy by spending – using borrowed or printed money.

Keynes emphasized the third. Roosevelt’s New Deal did not use that method, at least initially, and Keynes was especially critical of attempts to force up depressed prices by restricting output (which did nothing to increase demand).

Keynes was quite specific in his recommendations (paragraph 8): financing government spending by borrowing, not by taxation (as happens in war time). He specifically wanted borrowing for ‘shovel ready’ investments as with railroad improvements. In its early years, at least, until rearmament became a significant factor, Roosevelt’s, ministers were attached to more orthodox budget policies.

Keynes attacked the ‘monetarist’ approach of increasing money supply – paragraph 11 (‘it is like trying to get fat by buying a larger belt’). Yet, ironically, one of the lessons which American economists learnt from the inter war slump was that money supply does matter and after the 2008 crash it was aggressive monetary policy which dominated the response. Keynes also criticized the idea that devaluation was a way out of slump (while agreeing that it may be necessary).

Relevance of Keynes’ Letter to Today’s Policy Debates

How relevant are those arguments to recent economic policy debates? They are covered in detail in an exchange of articles in the New Statesman between Vince Cable and Robert Skidelsky, the leading biographer of Keynes:

There were three significant differences in the post-2008 recession in the UK and the problem which Keynes debated in 1933:

As a result of the banking crisis, banks were restricting credit to small business as they sought to reduce exposure risk. The practical implication was that demand stimulus would not be met by increased production, and employment (or, at least, in part).

The recession started with a large fiscal deficit, a ‘structural’ deficit, consequent upon the banking crisis which led to the semi-permanent loss of tax revenue from the financial services sector and increased, emergency, government spending. Government borrowing rose to 9% of GDP. Defenders of ‘austerity’ argued that if the ‘structural’ deficit was not dealt with there would be a crisis of confidence and the cost of government borrowing would rise sharply (as has happened in Eurozone economies).

Britain, much more than the USA, is an open economy. Increased purchasing power is likely to leak into imports. But, by the same token, a concerted approach by governments would have more benefits.

In the event, the UK relied heavily for recovery on expansionary monetary policy and very low, long term, interest rates which, as we have seen, Keynes regarded as very important.

Vince has highlighted the key differences between the post-2008 recession in the UK and the problems which Keynes’ debated in 1933. Comment below whether you think policy makers, in spite of these differences, have followed Keynes’ advice well. Should they have taken a different approach? How so?